Popularity of Cryptocurrency Has Auditing, Accounting Implications

Popularity of Cryptocurrency Has Auditing, Accounting Implications

Andy Segedin |

August 31, 2018

Your thoughts on blockchain technologies might vary based on the front page of your daily paper. One of the recent applications of blockchain includes a mobile-payment initiative by the Bill & Melinda Gates Foundation for areas in the world with limited access to traditional financial intermediaries. There also was a test of election balloting for overseas military by officials in West Virginia.

And then there is charitable donations of cryptocurrency, which is now one of the most common implementations of blockchain technology.

U.S. Securities and Exchange Commission (SEC) Chair Jay Clayton has stated that every initial coin offering (ICO) he has seen qualifies as a security and the commission is studying cryptocurrencies. Daniel Figueredo, CPA, partner and Nonprofit Industry Group Leader for BPM in San Francisco, Calif., discussed the changing landscape and related accounting and audit considerations during his session “The Impact of Blockchain to Nonprofits” at the 2018 American Institute of Certified Public Accountants (AICPA) Not-For-Profit Industry Conference in National Harbor, Md.

About half (45 percent) of conference attendees view blockchain technologies as having broad and lasting impact, per a poll. Another quarter (25 percent) of attendees see impact specific only to certain areas, while another 28 percent believe that the promise versus reality of blockchain is just now being understood. Greater than half (52 percent) of attendees responded that they would like to see the SEC take the lead on industry guidance. Other potential leaders included the Financial Accounting Standards Board (20 percent), AICPA (16 percent) and International Accounting Standards Board (11 percent).

Security is one of the most immediate concerns when dealing with cryptocurrencies. Figueredo referred to both public-facing and private-facing elements. The public aspect is similar to a post-office box in that it is necessary to have outward information to engage in transactions with others. The private element comes in the form of private keys and passphrases. Such private information should be tucked away, with safety deposit boxes an appropriate place to store written passphrases.

Currency can be lost forever once information is compromised. Unlike having one’s ATM personal identification number (PIN) compromised, those holding cryptocurrency cannot got to a bank and verify their identity and receive a new PIN code. In the realm of cryptocurrency, private keys and passphrases are the equivalent of one’s identity. When engaging with third-party custodians, cryptocurrency holders need to research the custodian’s qualifications, how quickly asset access can be obtained, and whether funds are to be held in a separate custodial account or a pool account.

If a person is the custodian of their own assets, storage of private passphrases and multi-signature protocols count among considerations.

How digital assets are to be classified is an ongoing question from an audit perspective. Bitcoin, the largest active cryptocurrency, has traditionally be treated as a commodity. Those “mining” cryptocurrencies might consider the assets as inventory. The majority of attendees (64 percent) indicated that they are hoping that U.S. Generally Accepted Accounting Principles (GAAP) classify cryptocurrency as a financial instrument. About a quarter (29 percent) of attendees responded that they would like to see cryptocurrency classified as a currency.

On the accounting side, tracking fair value of cryptocurrencies is extremely important, according to Figueredo. Some might choose the most advantageous market. Figueredo cited CoinMarketCap as reliable as it weighs multiple marketplaces. No matter the market used, accountants must disclose on what the cryptocurrencies’ values are being based.

Valuation also plays a major role in looking toward nonprofit-specific considerations down the pike. The Internal Revenue Service (IRS) treats cryptocurrency as contributed property, according to Figueredo. Private foundations face challenges relating to minimum distributions. If valuation is determined annually, and is caught at either a high or low point, the 5-percent minimum distribution of the foundation can vary widely depending on the composition of foundation assets.

Figueredo noted that the rise of cryptocurrencies has already had an effect on the legal profession and related necessary services. “Smart contracts,” contracts written into lines of code, maintain legal liability. Firms have sought out attorneys with coding backgrounds as examining the coding integrity of smart contracts has become a new type of service.

Asked by an attendee for nonprofit best-practices relating to cryptocurrency transactions, Figueredo said to focus on two elements. One, if the nonprofit is holding the cryptocurrency itself, leadership must educate themselves on relevant controls. Two, be sure that donor due diligence and donor-acceptance policies apply in the same way as any other donation. The same policies that would prevent an organization from accepting a gift from a donor who does not represent organizational values must be followed when dealing with cryptocurrencies, Figueredo said.